29 October 2008 External T.I. 2008-0286611E5 - thin capitalization

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Assume a corporation's second taxation year commences on June 16, 2007. For the purposes of computing the corporation's contributed surplus and paid up capital under clauses 18(4)(a)(ii)(B) and (C) of the Act, is "the beginning of the calendar month" the earliest moment of the day on June 16, 2007?

Position: No

Reasons: In computing equity for the second taxation year commencing on June 16, 2007, we can include any amount for paid up capital or contributed surplus at the beginning of the calendar month of June, 2007 even if that time is in a previous taxation year.

XXXXXXXXXX 								2008-028661
									Angelina Argento
October 29, 2008

Re:Subsection 18(4) of the Income Tax Act (Canada) ( the "Act")

This is in reply to your letter dated June 4, 2008.

FACTS

Assume the following situation:

Company A is incorporated on June 3, 2007;
Company A elects to have its first taxation year end on June 15, 2007 ("Year 1");

Company A's subsequent taxation year begins on June 16, 2007 and ends on June 15, 2008 ("Year 2").

ISSUE

The purpose of computing Company A's contributed surplus and paid-up capital under clauses 18(4)(a)(ii)(B) and (C) for June of Year 2, do the words "beginning of a calendar month that ends in the year" mean the earliest moment of the day on June 16, 2007?

OUR COMMENTS

The particular situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advance Income Tax Ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. However, we are prepared to offer the following comments which may be of assistance.

We have expressed the view that "the beginning of the calendar month" relevant for the computation of monthly averages of contributed surplus and paid-up capital, is a reference to the earliest moment of a particular calendar month, and therefore that an advance of equity on the first day of a calendar month can be included in computing a corporation's debt-to-equity ratio only if the advance is made at the earliest moment on that day. Based on this position, equity that is invested at any other time on the first day of a calendar month would not qualify for that month.

At the 2007 Canadian Tax Foundation we stated that in the context of a corporation that is newly incorporated, the term "beginning of the calendar month" means the date of incorporation, so that an advance of equity at the earliest moment on the date of incorporation will qualify for the debt-to-equity computation. Implicit in this response is that the first taxation year of the corporation ends at the end of a particular calendar month. In the factual situation you presented, the first taxation year of the newly incorporated company is from June 3, 2007 to June 15, 2007. Thus, there is no calendar month that ends during the first taxation year of the corporation. Accordingly, in your example, an advance of equity during this first taxation year of the corporation will not be included in computing the corporation's debt-to-equity ratio for its first taxation year. We also note that for the same reason, the amount described in subparagraph 18(4)(a)(i) of the Act is nil. Thus, subsection 18(4) is not an issue in Year 1.

For the purposes of computing Company A's contributed surplus and paid-up capital under clauses 18(4)(a)(ii)(B) and (C) for June of Year 2, the words "beginning of a calendar month that ends in the year" does not mean the earliest moment of the day on
June 16, 2007. Accordingly, contributed surplus and paid-up capital that is invested on June 16, 2007 will not be included in the computation of the monthly averages in respect of Company A's second taxation year beginning on June 16, 2007 and ending on
June 15, 2008.

However, in line with our comments at the 2007 Canadian Tax Foundation, in the case described above any advance of equity at the earliest moment on June 3, 2007 will be included in computing the June amount in the determination of the corporation's debt-to-equity ratio for purposes of subsection 18(4) of the Act for Year 2, since the calendar month of June, 2007 ends in that corporation's second taxation year (which commences on June 16, 2007 and ends on June 15, 2008).

We trust that these comments will be of assistance.

Yours truly,

Olli Laurikainen, C.A.

Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch